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As evident by its name, executive compensation is a type of payment that chief executive officers (CEOs) receive for their work. Nowadays, its composition includes salary, annual bonus, restricted stock and option grants, payouts from long-term incentive plans (LTIP), and various perquisites (Edmans et al., 2017). Different views exist on whether CEOs deserve such benefits and much higher compensation than regular workers (Edmans & Gabaix, 2016). The “shareholder view” argues that they do due having a greater impact on firm value, while another perspective considers regulations and taxes as the determining factors for CEO payment (Edmans et al., 2017, p. 385). The latter point connects executive compensation and the issue of the new tax law, which affects several aspects of the former.
The legislation is under consideration is the Tax Cuts and Jobs Act (TCJA), and it introduces three significant changes pertaining to executive compensation. One of them concerns Section 162(m), and while the other two, excise tax and equity grants, are no less impactful, it deserves attention due to its scope and difficulty in response (Schneider, 2018). First of all, it alters the definition of a “covered employee,” to which a $1 million deduction limitation applies, extending it to corporate financial officers (CFOs) (Schneider, 2018). Overall, the CEO, the CFO, and the other three high-paid officers are subject to the regulation, and a person is considered a covered employee if they assume one of those positions in the taxable period (Schneider, 2018). Furthermore, once an individual holds office from December 31, 2016, the limitation remains in place for the future, even upon their resignation or death (Schneider, 2018). It could be connected to the mentioned perquisites, which offer benefits for retirement and departure from the company (Edmans et al., 2017). Thus, the TCJA considers previously untouched parts of executive compensation.
In addition to those rigorous changes in Section 162(m), two more are worth highlighting. One removes such exceptions for the deduction limit as performance-based compensation and commissions, meaning that they will count for the total amount (Schneider, 2018). The initiative may cause companies to stop designing and administrating those, although some will be able to decide whether they want to preserve the former as an exception (Schneider, 2018). Prior to the new tax, many structures were established to maintain the exceptional nature of performance-based compensation, but they may no longer be necessary (Schneider, 2018). Another change extends the Section’s range, which now covers domestic and foreign publicly traded corporations and some private ones (Schneider, 2018). It could discourage the latter from preserving integrity in their fiscal reports, considering the situation’s novelty. However, the updated tax rates may ensure that compensation losses are negligible, although they will be in effect only until 2026 (Schneider, 2018). Altogether, the discussed changes extend the taxation’s reach and eliminate some exceptions, which will make companies revise their policies regarding executive compensation.
As far as the TCJA is concerned, its impact on executive compensation appears palpable. Code Section 162(m) alone undergoes numerous major changes, from extending the deduction limitation to CFOs and retirees to including private companies within the regulation’s reach and reducing the exceptions to the said limitation. While the revised tax rates may alleviate the effect of those provisions, whether corporations will adjust to the new reality and manage to preserve the high officer position’s prestige remains to be seen.
References
Edmans, A., & Gabaix, X. (2016). Executive compensation: A modern primer.Journal of Economic Literature, 54(4), 1232–1287. Web.
Edmans, A., Gabaix, X., & Jenter, D. (2017). Executive compensation: A survey of theory and evidence. In B. E. Hermalin & M. S. Weisbach (Eds.), The handbook of the economics of corporate governance (pp. 383–539). North Holland.
Schneider, P. J. (2018). The impact of the new tax law on executive compensation. Journal of Financial Service Professionals, 72(3), 29-36.
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